The most important takeaway for us from this Wednesday’s release of the Federal Open Market Committee July meeting Minutes will be whether they indicate enough progress on the revisions to the strategic policy framework that would keep it on course for its long awaited unveiling in September.
*** Although we have admittedly been a little surprised by the lack of a fuller messaging effort to preview more on the framework since the July FOMC meeting – perhaps the price paid in a slow consensus building process — we think the July Minutes will indeed show enough points of consensus in the framework discussions to set up its formal adoption at the September FOMC meeting. The Minutes are also likely to underscore how profoundly dovish the new framework will be in laying out the shift in the Fed’s reaction function going forward. ***
*** We are less certain, however, whether the Minutes will provide all that much clarity on the timing to a new policy guidance and changes to asset purchases. The July meeting three weeks ago was certainly far too early for a decision on policy guidance changes still two months away. At most, the Minutes may lay out the trade-offs in unveiling a strategic framework and a tactical guidance shift at the same meeting. In any case, guidance changes in the upcoming post-meeting statement will be largely data-driven, and are likely to be signaled only as the September 17-18 meeting draws nearer. ***
A Very Dovish Framing to Policy
The new framework, if indeed presented as we expect in September, will mark the culmination of nearly two years of Fedspeak sessions with various public groups, academic papers, scores of staff presentations, and successive Committee deliberations stretching across four FOMC meetings, interrupted by the Covid crisis, and resumed at the July meeting. Several Fed officials, including Chair Jerome Powell, have indicated the work on the framework review will be completed “in the near future,” which has been widely taken to mean September.
If the Minutes do indeed point to an emerging consensus on the changes to the framework it should, in turn, set in motion a communications campaign running to September through the August 27-28 “virtual” Jackson Hole conference hosted by the Federal Reserve Bank of Kansas City on “Navigating the Decade Ahead: Implications for Monetary Policy.” A keynote speech by Chairman Jerome Powell, or Vice Chair Richard Clarida who steered much of the framework review, would be key markers on the path to a September roll-out of the new framework.
In any case, an important starter gun to September will be this Wednesday’s account of the framework discussions at the July meeting. At minimum, the July meeting Minutes seem very likely to confirm a Committee consensus on the new language on its inflation mandate that will be written into the foundational “Statement on Longer-Run Goals and Monetary Policy Strategy.”
With just a few word changes and new phrasing in the longer run statement, the FOMC is set to confirm a profound consensus shift in the Fed’s reaction function to allow for an overshoot of the 2% inflation target, perhaps with language that may show up in the Minutes along the lines of an “average” attained “over time” to make up for the below inflation performance of the last decade.
Nearly every FOMC member has already given the nod towards the change in the approach to inflation going forward, but for it to make its way into what Fed officials consider a “constitutional” document like the longer run statement is what Chairman Powell meant when he said at the June presser that the new framework would “codify” policy changes that are more or less already in place.
And that inflation expectations have begun to modestly rise in recent weeks is one indication the market is already beginning to price in the likely implications of the Fed’s approaching new stance on inflation. The credibility of the shift is likely to be reinforced by the addition of the 2023 rate dot plots in September’s Summary of Economic Projections that will likely show a median overshoot in the 2% core PCE forecast. It also adds to the attraction of releasing the new framework at the September meeting.
And Equally, on the Employment Mandate
And while the new inflation consensus will be primus inter pares among the coming changes to the framework, the Minutes may also provide some indication of consequential changes in the approach to the employment mandate.
For instance, the current longer run statement states that “the maximum level of employment is largely determined by nonmonetary factors.” But judging by the rhetoric adopted by many Committee members in recent months on the economic effects of income inequalities or the wider social benefits in maintaining a high pressure economy to bring all groups into a tightened labor market, we would not be surprised if the Minutes offer hints that the Committee is finally conceding that monetary policy does have nearly an equal impact on the longer run level of employment.
And if that proves to be the case, against the backdrop of a widely recognized flattening if not near extinction of a Phillips Curve trade-off between tight labor markets and inflation, the Committee may have discussed in July revisions to the current “balanced” approach in assessing deviations from the mandate-consistent levels of inflation and employment — perhaps with a greater weight potentially to be given to letting the headline unemployment rate run a little lower and hotter for longer, even with the lagged effects of monetary policy on inflation.
We will also be parsing through the Minutes for any indication of a consensus movement on how to address the immensely difficult issue of monetary policy and financial stability. When the subject was discussed at length at the January meeting, some Committee members argued for a financial stability “safeguard” when weighing the risks in a sustained period of low inflation and very low interest rates constrained by the zero lower bound.
A hardening of the language referring to financial stability in the balance of risks may come up short of a consensus for a change in the longer run statement, but perhaps the Minutes will still indicate a financial stability safeguard could still make its way into the construction of the “outcomes-based” thresholds to frame a future guidance for policy when constrained by the Zero Lower Bound.
Guidance Optionality, For Now
An aggressive forward rates policy guidance is almost certain to feature prominently in any discussions that surface in July about the monetary policy ZLB toolkit in the context of the new framework. Equally, the Minutes should show a strong consensus favoring “outcomes-based” thresholds to frame the parameters of the lower for longer rates guidance. Both are likely to be reinforced with the balance sheet, either through large scale asset purchases, or in time and depending on the economic and fiscal conditions, yield curve control.
It has to be said there are not insignificant market expectations the new forward guidance – and QE in particular – will be paired to the post-meeting statement at the same time the framework is formally unveiled. It could offer the path of least regret to release both in September to lay the new guidance down before market sentiments potentially shift and “prematurely” steepen the yield curve, especially in light of the scheduled heavy pickup in Treasury longer term debt issuance.
But the July meeting three weeks ago was probably far too early for the FOMC to go beyond generalities to commit to details on the structure and timing to the new guidance language and QE.
And as a counterweight to those expectations for greater degree of signals on the guidance timing, there is a strong sentiment shared by many Committee member, at least in the calm of the summer, to decouple the broader strategic framework that is meant to apply to all conditions from a tactical implementation driven by the current economic outlook. We also have a sense in any case that the finer details of the thresholds still need to be ironed out, not to mention, depending on the data and revised outlook, the decision on the scale of asset purchases or whether they will be weighted towards longer term treasuries.
What’s more, the transition to monetary policy could be still delayed by any sharp downshift in economic activities or pre-election market volatility that could also effectively blunt the transmission of monetary policy, and even force a shift in the Fed’s policy calculations to the 13-3 facilities and a greater emphasis on direct credit policies like the to date little tapped Main Street Lending Facility.
In other words, with so much variance around the forecast going into the latter months of the year, the political uncertainties in the approach of the November elections, and now the stalled out passage of critical fiscal support to the recovery, it argues strongly for waiting until around the time of the Jackson Hole conference and the week prior to the pre-meeting blackout to signal likely intentions on the guidance and QE front.
Optionality on when to signal the transition to monetary policy and the new guidance and QE, in other words, is likely to be at a premium until Fed officials have edged closer to the September meeting.
A Delay Beyond September?
One last point, it also has to be said there is a low probability risk the Minutes will surprise with a lack of enough movement to a consensus on the revised framework itself that it could put the September release in doubt.
The issues surrounding such foundational changes are complex, and there is a strong view within the Fed that such a “constitutional” document like the longer run statement should be by a full consensus without dissent – which is never easy and always takes time – in order to ensure its credibility long after a change of the chair or individual FOMC members.
So there may be a case whether intended or not – and we doubt it will – to push the framework back to December or even back to January, the home of the longer run statement since 2012. But while the argument won’t make its way into the Minutes, we think there is a distinct majority view within the Committee that it will be in the Fed’s institutional interests to lay down its strategic framework before rather after the November elections.